|The government has been under pressure to check rising food prices, which have affected India's poor badly [Reuters]
Reserve Bank of India (RBI), India's central bank, has raised its key short-term interest rates by 25 basis points for the 10th time since March 2010 in an effort to check rising inflation.
The bank raised its repo rate - the rate at which it lends to commercial banks - to 7.5 per cent and increased the reverse repo - the rate it pays to banks for deposits - to 6.5 per cent.
The repo rate is now at its highest since November 2008.
"Inflation persists at uncomfortable levels and much above our comfort zone," Duvvuri Subbarao, the RBI governor, said in a statement released after bank policymakers met in Mumbai on Thursday.
The rate increase follows moves by China and Brazil to tighten monetary policy as the major emerging economies face a common battle of high inflation and economic growth that is easing from last year's fast rising pace.
The central bank's decision came after data this week showed annual inflation accelerated to a higher-than-expected 9.06 per cent in May, from 8.66 per cent the previous month.
The main drivers of inflation in April to May were minerals, textiles, fuel and nonfood manufactured products.
Analysts had expected the increase and said further hikes were still likely in coming months.
India's Sensex opened lower before the meeting, as investors sold heavily in anticipation of a rise.
The benchmark 30-share index on the Bombay Stock Exchange was 0.45 per cent lower in early afternoon trade after the announcement.
Interest-sensitive banking, real estate and auto stocks in particular were under pressure.
Inflation spilling over
The surge in the cost of living, triggered by spiralling food prices, rising global commodity prices and higher fuel costs, has been one of the biggest headaches for India's government.
Economists say inflation has now spilled over into the general economy, pushing up wages and other costs.
"The headline inflation rate remains extremely sticky at around the double-digit mark," Robert Prior-Wandesforde, India and South East Asia Economics head at Credit Suisse, the Swiss bank, said.
Reducing prices has become a political priority for the federal government, even as higher growth is seen as key to reducing crushing poverty in the nation of 1.2 billion people.
The government has delayed a decision to raise prices of diesel and kerosene, which is widely used in rural areas and is seen as the "poor man's fuel".
A possible hike in diesel would stoke inflation further, as it is a widely used in the transport of goods and services across the country.
The RBI on Tuesday said inflation was likely to face continued "upward pressure" from the impact of high oil and coal prices, government subsidy expenditure and wage rises.
India suffers from the worst inflation of any major Asian economy despite the RBI's aggressive rate hikes, suggesting that curing the problem will require structural reform, rather than monetary policy alone.